• The Same Tired Old Excuses

    As job losses reach crisis proportions, and many point the finger at an overvalued exchange rate, we have to put up with the same old tired and ill-informed assertions to the effect that overvaluation is not the culprit.

    Those who say this usually make two assertions; first, the exchange rate is irrelevant and secondly, there’s nothing we can do about it anyway. Neither assertion is remotely accurate.

    As to the first, the usual line is that factors other than price matter in international markets; yet only a moment’s thought will produce the commonsense conclusion that it would be very surprising if we could charge whatever we like. If we ask more for our products than the market says they are worth, we will have trouble selling them, or at least selling them at a profit. To argue otherwise is to deny simple reality.

    The one sure way of ensuring that we have to charge more than we should is to allow the exchange rate to rise too high. The exchange rate, after all, converts all our domestic costs of production – for labour, energy, raw materials and so on – into the prices we charge in international markets, and that includes our own, where we compete with imports. As the rate rises, it ensures that those prices are artificially inflated, and are no longer competitive. Even on those sales we do make, it cuts the profit margin – just ask the dairy farmers; the whole economy suffers as the cream is blown off the top of our dairy exports by the overvalued dollar.

    That is why, in a nutshell, we can’t pay our way in the world, and have to borrow excessively to cover the gap between what we can sell and what we want to buy. That is why we dare not grow our economy fast enough to bring down unemployment; it’s because we know that if we do, we’ll run into balance of payments constraints and will have to borrow even more.

    We’ve been doing this for so long that we think it is natural and unavoidable. That’s why ministers in successive governments over three decades have believed that solemn lectures about improving productivity, and promising that new research – always “soon” – will generate new “sunrise” industries, will do the trick. As any manufacturer will tell you, if the profit on your exports is decimated by the exchange rate, you have no money to re-invest in improving productivity, funding new research and technology, or taking any of the other steps needed to close the gap on better-resourced international rivals.

    The second argument is the fallback position always adopted by those who have run out of other arguments. All this may be true, they say, but there is nothing to be done about it. The dollar’s value is established by the market and reflects the fortunes of other currencies, like the US dollar. If that means a high New Zealand dollar, we just have to live with it.

    But this is nonsense. There is no such thing as a clean float. The view that the markets take of the Kiwi dollar is strongly influenced by what they know to be government policy, especially if that policy has a direct bearing on the dollar’s value and has been maintained for decades so that there is little prospect of it changing.

    What determines the value of the dollar, so that it is higher than it should be in terms of balancing our trade, is quite simple; it is the fact that we have for many years offered investors – especially overseas investors, the legendary Japanese housewife or Belgian dentist – an interest rate premium for buying New Zealand dollars. That premium has been so high for so long that short-term investors find it worthwhile to borrow money they don’t have at low interest rates in their own countries so that they can buy New Zealand securities at a high rate of return; and because so many do this, the demand for and therefore the price of the New Zealand dollar rises, and the investors make a capital gain into the bargain.

    The only people who lose from this are the people and businesses of New Zealand. Why does our government go on allowing this to happen? Because we insist on using high interest rates as our main, indeed only, counter-inflation tool; and since those high rates destroy our competiveness by pushing up the value of the dollar, we are then forced to borrow even more at even higher rates.

    Quite apart from other factors – like commodity prices and the terms of trade – that influence the value of the dollar, the main element of over-valuation is, in other words, a direct consequence of government policy. We could change that tomorrow if we wished. We need to understand that high interest rates and the overvalued dollar are not only damaging our economy but are not even appropriate as counter-inflationary tools. If we addressed the real reasons for inflation – excessive bank lending and credit creation for non-productive purposes – we could stop the insane process of deliberately pricing ourselves out of world markets.

    Bryan Gould

    12 September 2012

    This article was published in the NZ Herald on 14 September.

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